A Tale Of Two Impacts

With a title like "A Tale Of Two Impacts", the temptation is high to offer some sort of Dickensian quote to kick this post off... but I'll spare the reader. Instead, I'll start by observing the surreal juxtaposition of an security-and-canapés event hosted by Rockefeller Advisors and the Federal Reserve Bank followed promptly by the impact mosh pit known as SOCAP. With my punk roots (yep, my high school band was named "Gang Green" - an early nod to environmentalism?), one would have thought that the latter would have been the more interesting. Well... one would have been wrong.

The former was an invitation-only convocation of thought leaders (or, as my partner Rick likes to say, "thought heads"), practitioners and professionals in the impact space, intended to provoke specific conversations on bringing impact to institutional scale. The latter is very much what the term "mosh pit" implies: a crush of entrepreneurs, investors, thinkers, intermediaries, philanthropists and the typical groupies, all banding together in a chorus of saving the world with capitalism. Inspiring stuff, for sure.

But - surprise! - it was the staid, jacket-and-tie (I was the only guy in the room wearing jeans) crowd that I found the more compelling. Why? Because, as I have written in the past, for impact investing to grow beyond the niche in which it currently sits, it has to attract institutional capital. And for it to attract institutional capital, it has to offer more than promise. It has to offer a credible, visible, comparable alternative to conventional investing.

Obviously, from a "mission aligned" perspective, impact investing may appeal to a wide institutional audience, primarily philanthropic. But, as one of the attendees pointed out, most institutions need return on capital. They have actuarial expectations they must feed, retirees who need to be paid, union bosses who must be managed, etc. In other words, they can't take big risks on promises and warm fuzzies.

Particularly in a world of punitively low interest rates, the need to seek historically high rates of return in unconventional asset classes and unfamiliar sub-asset classes has never been greater. And as was conveyed with brutal candor by several guests, if a fund leads with "impact" as opposed to leading with "return", they won't even get in the door.

Interestingly - or conveniently, depending on one's perspective - I am seeing more "institutional quality" investments with an impact component than ever before. As proof, David Chen sent me an email only a few hours after the Fed meeting broke, detailing a $180mm investment by the a large state employee pension plan into a sustainable animal husbandry fund based in Australia (due to SEC regulations, we can't share the name of funds like this in our blog, as doing so may be construed as a recommendation or offer to sell). The accompanying text says it all: http://www.pionline.com/article/20120928/DAILY/120929869

(in a blinding moment of serendipity, Dave sent me this link as I was typing the previous sentence: http://www.huffingtonpost.com/david-bank/impact-alphas-stake-their_b_1958616.html Perfect timing.)

Don't get me wrong. The SOCAP mosh pit crowd is definitely my tribe. The emphasis on excellent chocolate is enough to secure my attendance. But, when I'm being really honest with myself, the key to impact investing's future lies with the tie-and-jacket crowd at the Fed Building. And, again being honest, I like that. It feels intellectually rigorous. It feels mainstream. It feels sustainable. And if those of us in the impact space truly desire a world in which the power of the capital markets is harnessed to address the Great Challenges we face, we are going to need every sharp mind in the room.

Two issues need to be addressed: Asset Class and Exit Strategy. Institutional investors have the scale and longevity to invest directly into the real economy, becoming partners in the productive use of productive assets and recovering capital and realizing returns from the real economy, through their agreed split in the cash flows generated in consequence of their investments. Almost any direct investment into the real economy can be structured to deliver both alpha and impact, to achieve both financial and societal objectives. Financial objectives are the same for every institution: principal protection; programmed performance; threshold returns; constancy; transparency; and alignment of interests. How much of this can you actually get from the Securitized Economy? Societal objectives can be custom-crafted to the stewardship sensitivities of the investor(s): climate stability; resource stewardship; social mobility; financial integrity; global community; economic adaptability. All of these are "market externalities" in the price-and-price-alone ecosystems of the Securitized Economy. The investing skills of most institutional investors, however, continue to be dominated by the principles of Asset Allocation according to Modern Portfolio Theory, which only apply to the Securitized Economy. Impact Investing can and should be a catalyst for teaching Institutions the skills they need to see that new value creation in the real economy almost always evolves outside of established asset classes. These, after all, are silos for containing the received wisdom about how the economy used to be architected, back in the past, when those assets were first being classified. Impact Investing can and should also be a catalyst for teaching Institutions that Exit by Sale is not their only, or even their best, option for recovering principal and realizing returns. If they invest in cash flows -- instead of securitized asset prices -- then they can recover pr